Want to Defer Real Estate Capital Gains Without Buying a Like-Kind Property?

Want to Defer Real Estate Capital Gains Without Buying a Like-Kind Property?

Have you sold real estate within the past 180 days?

If you are under pressure to comply with IRS Section 1031 to complete a tax-free exchange, you should know that there is a compelling alternative.

Instead of the usual (having to identify a replacement property (and one or more alternative replacement properties in compliance with IRS rules, just in case a replacement property falls through) within 45 days of selling the original property, escrowing the sale proceeds with a 1031 qualified intermediary, and closing on a replacement property within 180 days of the sale of the original property), investing capital gains from the sale of the original property into a Qualified Opportunity Zone Fund (“QOF”) might be the better choice.

Consider an investor who sold real estate at a good price but isn’t prepared to buy back into a market where 30-year fixed mortgage rates are quoted above 6.5%.

Most real estate investors just assume that a 1031 exchange is their only option!

As a result of changes to the Internal Revenue Code enacted as part of the Tax Cuts and Jobs Act of 2017, taxpayers who sell real property (or any other type of property) at any time during a rolling 180 day look back period, can reinvest the capital gains from that sale into certain underdeveloped parts of the country (designated as Opportunity Zones), via QOFs and, as a result, can defer and even possibly eliminate the capital gains taxes otherwise due on the sale until the end of 2026. In addition, unlike a 1031 exchange, the appreciation that an investor may realize on capital gains invested into a QOF can be tax-free if the investor holds that QOF investment for at least 10 years, up to December 31, 2047.

The 2022 clock is running down. In the United States there are more than 8,700 designated Opportunity Zones for investors to consider, but they are not all created equally: the quality of their management teams can vary, as can their investment strategy and their fees.

We can help you shortcut the process and identify for you one or more Opportunity Zones that may make sense for you -- ones that we have done due diligence on and pre-screened to save you time.

Despite their tremendous tax benefits, it is important that you have first done your homework on the merit of the underlying investments in the Opportunity Zone investment fund before you consider the tax benefits.

I've seen too many instances where people have let "tax allergies" and persistent salespeople sucker them into mediocre investment funds; that is a bad idea, no matter how good the tax benefits are for the reason that you need to protect your capital otherwise your bottom line will suffer.

Just for context, if you look hard enough, you can find some well-designed Opportunity Zone funds that are investor-friendly.

One that we have been employing for clients, for example, as a fee structure that we believe is quite reasonable (no investors servicing fees, no disposition fees, a 0.75% annual management fee and a modest 5% carried interest). By contrast, too often, we find funds that have additional fees buried deep in their deal documents.

This is just one example. As mentioned above, there are many flavors to pick from and it is important that you select one that lines up with your risk tolerance and objectives. For further context, here are some additional features of that same fund, which as you can see, compare favorably with other real estate investment funds out there based on our experience:

• providing for pass-through income, thereby avoiding double-taxation for investors;
• providing for pass-through depreciation, with no depreciation recapture if an investment is held for 10 years up to December 31, 2047;
• providing low investment minimums, allowing for non-accredited investors access to the investment class;
• requiring annual distributions of at least 90% of taxable income;
• providing for up to a 20% reduction on taxable distributions via Internal Revenue Code Section 199A;
• providing investors with greater control over their exit timing and amount;
• no future capital calls; and,
• the best part: unlike many other OZ funds and 1031 exchange structures, this particular fund is liquid, which gives you even more flexibility and control over where your capital is invested and the timing of when you want to recognize your gain, which can be helpful for tax planning purposes (subject to all the usual caveats as it relates to future liquidity).

In short, you do not need to feel trapped. A 1031 exchange is not your only option. That said, all the options have important deadlines and time limits so you need to get on this sooner than later.

If you have someone on your team that has strong tax planning expertise, there are a number of things you can do to save on taxes. The difference that tax planning can often make on your ability to build wealth is staggering.

This article covered just one technique, but there are many more. If you are suffering from tax allergies, reach out and let's talk tax planning. There is often a lot that you can do using simple and straightforward strategies that are permitted by the I.R.S. Where you get into trouble is when you either get greedy and fall prey to "too good to be true" type schemes. Avoid those at all cost. They are not worth it. They will likely land you in a nasty audit and the fees that you will have to pay to lawyers and accounting firms to defend that audit will be costly; worse yet, you will likely have to pay the tax anyways, along with additional penalties and interest.

That said, if there are legal and straight forward ways to minimize your tax burden, it makes a lot of sense to incorporate those into your financial planning and investment process.